Big Story: Investment ideas for 2020 from leading fund managers

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A narrow rally in stocks and debt defaults saw investors get a rather raw deal in 2019. We ask leading fund managers what’s in store the coming year

Equity: Pockets of opportunity

Mahesh Patil, CIO - Equity, Aditya Birla Sun Life AMC

Large-cap indices and stocks have moved up sharply over the past year even as mid- and small-caps have been struggling. Will the good run for large-caps continue in 2020?

While the large-cap Nifty index is up 12 per cent y-o-y, the mid-cap index is still down 4 per cent y-o-y and the small-cap index is down 10 per cent y-o-y. Investors have gravitated towards large-caps as they provide safety and better earnings visibility and are also gaining market share.

We expect the economy to recover gradually going forward, and large-caps should continue to be steady performers. However, mid- and small-caps, which typically have a higher exposure to the domestic economy, could outpace large-caps once we start seeing signs of a sustained economic recovery. CY20 should likely be a year of market consolidation and transition — from a narrow rally to a broader market participation.

How are valuations in different segments of the market currently ?

Due to lack of economic growth, quality has outperformed and a few expensive large-cap stocks have become more expensive. This is evident from the fact that since January 2018, only the top 10 market- cap companies in the large-cap Nifty 50 index have run up, whereas the rest 40 companies by market cap still have a lot of room to catch up.

The large-cap Nifty 50 index is trading at a one-year forward P/E of 20x, which is at around 20 per cent premium to its long-term average.

However, it may not paint a complete picture as the top 10 market-cap companies are skewing the valuation.

The rest of the 40 companies in the Nifty are trading at around 17x, which is close to the long-term average.

Hence, even as the risk-reward for large-caps seems fairly balanced, there are pockets of opportunity even in large-caps.

The mid- and small-caps are still trading at a discount to the large-cap Nifty. Due to the brief rally in the mid-caps over the past two months, the discount has narrowed somewhat.

However, a large number of mid- and small-cap stocks have still not recovered from the 25-50 per cent fall from their highs.

Is it getting tough for large-cap fund managers to outperform the benchmark indices?

The past year has been tough for fund managers. We have seen a narrow rally, limited to a handful of stocks, and the broader market has not participated. Hence, diversified large-cap funds have not been able to put up a good performance versus passively managed ones — active funds typically have an overlap of only 40-60 per cent with the benchmark and hold a broader portfolio to generate outperformance. However, we believe that the narrow rally and its impact on performance is a passing phase.

With a gradual recovery in the economy, the broader market should see a revival, and the relative performance of funds versus their benchmarks should improve.

We do not expect investors to flock to passively managed funds in India, at least for the next five years. In contrast to developed markets such as the US, actively managed funds in India have been outperforming their benchmark over the long term, with the past 1-2 years being an exception.

Fund managers still have ample opportunities for generating alpha.

For example, in the case of large-cap schemes, the benchmark is the Nifty 50 index, but fund managers can also invest in large-cap companies outside the Nifty which have given superior returns over the past five-year time-frame.

Over the long term, mid-caps have given higher returns than large-caps, and fund managers can invest in high-potential companies in the mid-cap space. India being a growth market, several emerging companies get publicly listed every year, and fund managers can invest in their IPOs before these companies enter the index.

Also, the Indian market is still not fully institutionalised. Out of India’s total market capitalisation, FIIs (foreign institutional investors) constitute 15 per cent, retail investors more than 10 per cent, and mutual funds around 8 per cent. At times, FII buying and selling is driven by global liquidity rather than fundamentals, and domestic fund managers can use this to their advantage. Swings in retail investor sentiment also contribute to market inefficiency, providing an opportunity for fund managers.

Do you expect a recovery in corporate earnings this year? What will drive the recovery?

India’s economic growth has likely bottomed out and should recover gradually. The government and the RBI are continuing with their coordinated fiscal monetary policy response, and the impact of these measures is typically seen with a 6-9-month lag.

Corporate earnings growth is likely to pick up in line with an improvement in the economy. The gradual economic recovery should lead to higher top-line growth. Raw material prices have fallen 5-30 per cent in the past 12 months, helping gross margins and the bottom-line. Corporate tax rate cut should also support earnings growth.

For FY21, the projected earnings growth for the large-cap Nifty 50 index is around 23 per cent, driven largely by corporate banks which have seen NPL (non-performing loan) resolutions, increased recoveries, and capital infusion for strengthening their balance sheets.

Other sectors which had seen subdued earnings in FY20, such as auto and pharma, should also do well.

Fixed income:Credit risk aversion will continue

Murthy Nagarajan Head Fixed Income, Tata Asset Managment

The RBI has not cut rates in its last policy review. With inflation rising, and the risk of fiscal slippage staring at us, how much of a headroom does the RBI have to cut rates?

The RBI has a forward- looking consumer inflation survey which shows that consumers expect CPI (consumer price index) inflation to go up by 120 basis points and 180 basis points in the next six months and 12 months (respectively).

Finance Ministry officials have stated that they will give priority to growth over fiscal restraint.

CPI inflation is not expected to come below 4 per cent till the second half of the next financial year. However, if the monsoon is good, the RBI may go for a 25-50 basis points of rate cut in the first half of the next financial year as growth impulse continues to be weak.

Debt funds have been hit by a series of defaults and downgrades. What is your view on credit risk in the coming year?

We do not expect growth to pick up in the coming quarters. It may take 3-4 quarters for the economy to improve. Credit risk aversion is expected to remain a dominant theme in the coming year.

FPI flows have been strong in the debt segment. What will drive such flows in the coming year? What are the risks to these flows?

FPI (foreign portfolio investment) flows are strong across most emerging markets; India is a beneficiary of this trade.

FII (foreign institutional investor) flows in debt also mirror expectation of the rupee movement as FIIs are concerned with dollar returns.

India has received good FII flows due to the Essar (Steel) resolution.

If the Aramco deal of Reliance and the BPCL divestment happen, these flows are expected to increase.

The RBI has been intervening in the currency market to control rupee appreciation. As global yields are low, investments in debt securities offer good carry returns to FII.

Since September, the spread between 10-year G-Secs and two-year government securities has widened to 90-100 basis points, impeding transmission. Do you think the RBI will intervene to correct the anomaly?

The RBI is concerned with the rise in long- term yields, as the market factors in additional borrowing from the the government. Since the balance sheets of corporates and households are deleveraging, only the government can pick up the slack for investment and consumption expenditures. The supply of the Central and the State government papers is ₹25,000- 30,000 crore every week, which cannot be absorbed at the current yield.

The RBI has started to buy the long-dated papers and sell the short-dated papers to reduce the term premium. It has to continue doing this, as yields will move up if it stops after doing one more (operation).

What should investors in debt funds do at this juncture?

Even though there is a short-term window of trading opportunity due to the RBI purchase, the high CPI inflation and fiscal deficit will test the yields. Liquidity is expected to be easy as growth is weak, and the RBI is buying dollars and supplying rupee to the system.

Investors should invest in short- term bond, as well as banking and PSU funds. Investors having a shorter-term horizon can invest in money market funds.

Passive investing:Decline of alpha likely to persist

Vishal Jain, Head - ETF, Nippon India Mutual Fund

Actively managed large-cap funds have underperformed the benchmark Nifty 50 TRI. This has led to increased investor interest in passive funds. Will this trend continue in 2020?

The underperformance of active funds has become even more visible in the recent times, mainly because of regulatory changes. Some of these are: 1) SEBI’s scheme categorisation definitions; 2) fair performance benchmarking using Total Returns Index (index inclusive of dividends); and 3) adoption of full trail commission for distributors, ie, abolition of upfront commissions.

Moreover, Indian markets are turning ‘informationally’ efficient day by day, due to the ever-increasing quantum of money managed by professional managers.

Hence, the ‘outperformance’ of individual managers will be increasingly short-lived due to competition.

This has resulted in the secular decline of ‘alpha’, which is likely to continue in the Indian markets.

How can the passive investment strategy help retail investors achieve their goals?

There are two broad risks in investing — systematic risk (general market risk) and unsystematic risk (any other kind of risk, such as stock- specific, sector-specific, fund manager, etc).

Systematic or market risk is common to both active and passive investments. Passive investing minimises the unsystematic risk, as one is investing in the constituents of the underlying index and not the fund manager.

Investors can achieve their investment objectives by using a combination of both passive and active strategies through the ‘core and satellite’ approach. The core (main part of the portfolio which is usually larger) of one’s portfolio should always be a low-cost ETF (exchange-traded find)/index fund linked to a broad market index, as this would give true market returns, instead of taking the unnecessary risk to outperform. The satellite (smaller part of the portfolio) portion can be used for taking additional risk through various active strategies.

It is a well-studied fact that asset allocation is the paramount factor that drives the majority of portfolio returns. It is only passive funds that can give exposure to broad segments and sub- segments of the equity markets, commodities, fixed income and money market, thus enabling efficient asset allocation consistent with your financial needs, risk tolerance and investment horizon.

Passive funds are low-cost; for example, a Nifty 50 ETF is available to an Indian investor at an annualised TER (Total Expense Ratio) of as low as 0.05 per cent pa. If we compare this with an average large-cap active fund TER, which could be anywhere between 1.5 per cent and 2 per cent annualised, it results in larger accumulation of wealth due to savings in cost.

What parameters should retail investors look at while investing in ETFs?

An ETF has three legs of costs — TER or annualised expense ratio, tracking error, and liquidity or volumes on the exchanges.

Intuitively, investors/ advisors consider only the first two components — expense ratio and tracking error. However, volumes, or liquidity, on the exchange is an extremely important factor for ETFs, as they are traded in the secondary market. ETFs having the highest volumes/liquidity on the exchange should be considered. This information is easily available on NSE/BSE websites.

How good is smart-beta ETFs for Indian investors? Are they worth looking at?

It should be noted that smart-beta strategies don’t fall purely under the passive domain. When traditional market cap-weighted indices are tweaked, based on factors such as size, value, momentum, volatility, fundamental factors, etc, they are called smart-beta indices. However, like any other active strategy, smart-beta strategies can result in outperformance/ underperformance to the traditional market cap- weighted index.

A good mix would be a ‘core and satellite’ approach as explained above. The satellite component of your portfolio can be allocated to smart- beta strategies.

Global exposure: Increase allocation to international stocks

John Praveen, Managing Director and Senior Portfolio Manager at QMA, a PGIM company

Global stocks, especially those from the US, have been rallying despite concerns about economic growth and trade wars. Do you expect this to continue? Or is a correction on the cards in 2020 due to stretched valuations?

The key driver of the strong gains was aggressive monetary stimulus, with 50 central banks delivering over 100 interest rate cuts — the largest easing since the financial crisis. This led to P/E multiple expansion, and fuelled the stock market gains. Stocks also benefited from a reduction in trade tensions and the Brexit uncertainty.

While it will be difficult to repeat the strong gains in 2019, we expect stocks to post further gains in 2020 as rate cuts in 2019 should boost global growth and a recovery in corporate earnings. Further, while valuations rose in 2019, the markets are not very expensive.

The World Stock Index (MSCI ACWI) is trading at 16x price/earnings ratio, below the current cycle’s high (in 2017). Further, stocks are cheaper than bonds as the gap between earnings yield on stocks and bond yields remains wide.

Will recent developments such as the impending closure of the Brexit issue and a seeming thaw in the US-China trade relations provide tailwinds for the global economy and stocks? What other factors can make or mar the global economy and stocks in 2020?

Yes. The global economy and stocks should enjoy tailwinds from easing trade tensions with a Phase 1 US-China deal, and the UK on track for an orderly Brexit in 2020, after the Conservative party’s big win in the December elections.

Further, fiscal stimuli are likely in the UK, Europe, Japan, China and other emerging markets (EMs). Monetary policy also remains supportive, with the ECB (European Central Bank) continuing QE (quantitative easing) and rate cuts in the UK and several EMs. Finally, recession fears are receding, which should support stocks.

Which geographies are likely to do well or relatively better in 2020, and why?

The US stock market outperformed other stock markets in 2019 and in the past 10 years, with relatively stronger GDP and earnings growth and large exposure to the tech sector, which rose 45 per cent in 2019. However, many of these factors are likely to reverse in 2020, and the international markets are likely to outperform the US.

The UK, Europe and the EMs are expected to enjoy a growth rebound in 2020, while the US growth is likely to remain stable. Corporate earnings are also likely to be stronger in international markets (15 per cent) than in the US (8 per cent). Further, non-US stocks have cheaper valuations than the US stocks.

EMs should benefit from reduced trade tensions, solid earnings growth and improved liquidity. The UK and Europe should benefit from fiscal and monetary stimuli. Hence, the UK, Europe and EM stocks are likely to post stronger gains in 2020 than stocks in the US, which should post solid gains.

How long will negative interest rates continue in many global economies?

On the policy side, the ECB and the BoJ (Bank of Japan) are likely to keep negative interest rates through 2020 and beyond (in Japan). However, market interest rates are likely to turn positive in many countries as global growth picks up and fears of recession recede.

Given the challenges in the Indian economy and stocks, should Indian investors increase or reduce their allocations to global stocks in 2020? What should the range of global funds/stocks be in the asset allocation mix?

Yes, Indian investors should increase allocation to global stocks both for portfolio diversification and as a safe haven, in case of weakness in the Indian market. With about 98 per cent of the global market cap outside of India, Indian investors have a big opportunity to gather international exposure.

Traditionally, investors have around 20 per cent allocation to markets outside the home market. This applies to Indian investors’ allocations to international markets.

What is your outlook on the prices of commodities, including crude oil, in 2020? Where could the rupee be headed?

The outlook for commodities is likely to improve as global growth rebounds in 2020. However, since the growth rebound is likely to be modest, the rise in commodity prices is likely to be limited. Oil prices are likely to trade in the $50-70 range as supply cuts and improved global growth boost oil prices, while increased US shale supply is likely to push prices down.

The rupee is likely to recover as Indian GDP growth rebounds from the 2019 slowdown and the government continues reforms.

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Published on
December 28, 2019

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